JOURNAL 43

WHY DOES THE GOVERNMENT INCENTIVISE TAX AVOIDANCE?

Over the weekend I caught up a bit on my reading. One thing that caught my eye in reading the parliamentary debates on the Second Reading of the Finance Bill was a comment by the Financial Secretary to the Treasury, John Healey, on small businesses. He said:

“The UK has 4.3 million small businesses. Of those, more than three quarters are self-employed. They do not pay corporation tax and are not affected by the changes in the Budget. Of those that remain about a quarter do not pay any corporation tax because they do not declare profits. Of those that remain, we estimate that the majority have incorporated with the purpose of reducing their tax and national insurance liabilities.”

That seems an extraordinary statistic:

Unincorporated businesses 1,075,000

Small companies not generating

any profits or making losses 806,000

Small companies that have incorporated

solely for tax avoidance purposes 1,210,000*

Small companies that have incorporated

in order to obtain limited liability or for

some other commercial purpose 1,209,000*

Total UK small businesses 4,300,000

I have taken “the majority” to mean just over half, so the number of “genuine” incorporations of profit-making businesses may well be significantly lower than £1.2m – although some of the non-profit generating businesses may of course be profitable businesses that distribute the whole of their profits to their proprietors by way of salary.

For most government purposes a small business is one that has less than 50 employees and a turnover of less than £5.6 million.

The above figures suggest that if tax avoidance could be abolished (which it can’t be) only around a quarter of all small businesses would choose to operate as limited companies. I find this amazing. It is also alien to my personal experience, which is that the vast majority of small companies that I have come across have incorporated to obtain the benefit of limited liability, to be able to give senior employees an interest in the business, or to segregate activities into different entities.

Of course in the fast growing IT industry, many have incorporated because the large computer companies, most of whom do work for the government, are unwilling to deal with PAYE and NIC as unpaid tax collectors for the government, and the government, in particular the Treasury and HMRC, have been unwilling to make a stand and require its own IT contractors only to use their own employees to fulfil government contracts. I am unclear whether Mr Healey regards small companies set up to enable the proprietor to obtain work from government contractors as falling within the tax avoidance or commercial category. As it is really government sponsored tax avoidance I suspect it is the former.

The other extraordinary thing is that over the last 10 years the government have directed the vast majority of its small business incentives towards companies – indeed to such an extent that many commentators and advisers were convinced that the government was seeking to discourage unincorporated businesses completely.

It seems an extraordinarily odd policy to hand out benefits to 1.2m avid tax avoiders in order to benefit a smaller number of genuine businesses. It seems an equally strange policy to choose to incentivise only around half of all genuine small businesses (Incentives that relieve the corporation tax burden have no effect on companies that do not make profits so cannot impact on that 800,000). Yet this is what Mr Healey’s figure suggests that Gordon Brown has consistently chosen to do.

Robert W Maas